Alan Caruba's blog is a daily look at events, personalities, and issues from an independent point of view. Copyright, Alan Caruba, 2015. With attribution, posts may be shared. A permission request is welcome. Email acaruba@aol.com.

Thursday, October 30, 2014

Making It Easy to Predict the Next Financial Crisis

By Alan
Caruba

It is a
cliché, but true, that history repeats itself. This is largely due to the
failure of each new generation to learn anything from the past as well as the
human tendency toward the bad habits of greed and power-seeking. Only the names
and faces change.

That is
why the next financial crisis is entirely predictable.

On October
23, The Wall Street Journal had an
article, “Relaxed Mortgage-Lending Rules Clear Final Hurdle.”The financial crisis in 2008 was the direct
result of relaxed mortgage-lending rules. Indeed, it was the result of
government pressure on banks to make “sub-prime” loans to people who any bank
might sensibly conclude could not replay them. Those loans, in turn, were sold
to Fannie Mae and Freddie Mac, two government-sponsored enterprises, who then
bundled and sold them as mortgage-backed assets.

As
Wikipedia notes, the Federal National Mortgage Association, commonly known as
Fannie Mae, was founded in 1938 during the Great Depression to expand the
secondary mortgage market by securitizing mortgages by issuing mortgage-backed
securities, allowing lenders to reinvest their assets into more lending. In
1970 the Federal Home Loan Mortgage Corporation, whose nickname is Freddie Mac,
was created for the same reason. Both are overseen by the Federal Housing
Finance Authority. Neither issues mortgages. As noted, they buy them from
banks, bundle them as securities, and resell them.

Getting
the government involved in the housing market has been a supremely bad idea,
much as getting the government involved in education and, as we are learning,
involved in the nation’s healthcare insurance sector. There are only a few
things the Constitution authorizes the government to do and none of these are
mentioned. That has never stopped politicians.

The Wall
Street Journal article reported that “Three U.S. agencies signed off on relaxed
mortgage-lending rules, helping complete a long-stalled provision of the 2010
Dodd-Frank financial-overhaul law.” Two commissioners of the Securities and
Exchange Commission “warned the rules would do little to prevent a return to
the kind of lax mortgage underwriting that fueled the financial crisis.”

The Economist also took note, saying “When
politicians bashed Wall Street for its reckless mortgage lending in the wake of
the subprime crisis, bankers retorted that it was the politicians’ enthusiasm
for expanding home ownership, even if it meant small deposits and low credit
standards, that had really fomented the disaster.” Suffice to say there is
plenty of blame to spread around, but the banks had to play by the rules the
government had put in place.

In the
wake of the financial crisis “many banks have stopped lending to riskier
borrowers” but the new rules simply recreate the conditions that led to it,
although “the rules only affect the tiny market for securities issued without
federal backing, less than 2% of the $1.58 trillion in mortgage securities
issue in 2013…”

The rule
changes are being hailed as an example of the how great the “reform”
implemented after the financial crisis was in the form of the Financial
Stability Oversight Council and Orderly Liquidation Authority, otherwise known
as the Dodd-Frank Act.

Suffice to
say it is a regulatory nightmare of several thousand pages of rules, often
quite vague, that are still being interpreted. That said, its purpose, to
prevent predatory mortgage lending, improve the clarity of mortgage paperwork
for consumers, and reduce incentives for mortgage brokers to push home buyers
into more expensive loans was needed. It also changed the way credit card
companies and other consumer lenders had to disclose their terms to consumers.

As The Economist noted, the agreement
regarding mortgage-lending rules “would permit banks to securitize and sell
mortgages without retaining a 5% stake—leaving them little incentive to
maintain high lending standards.” That needs repeating: little incentive to maintain high lending standards, the very
reason we had a financial crisis in 2008.

All this
is largely due to the progressive notion that everyone, no matter how little
they earn, should be able to purchase a home. In reality, those at the low end
of the economic ladder should not be encouraged or seduced into taking on such
debt. When they do and the economy goes south, leaving them unemployed, they
just walk away from the debt.

Why should
the rest of us—taxpayers—bail out the mortgage sector as we did in 2008 with
huge loans to the banks and insurance companies that had purchased mortgage-based
securities? The government had to step in with the complete government takeover
of Freddie Mac and Fannie Mae. We got stuck with the bill.

It also
drove up our national debt, leading to the first reduction in the nation’s
credit rating in its history.

There is
already talk on Capitol Hill that, should Republicans take control of the
Senate and retain it in the House, they are likely, as Reuters reported, “to
target the Consumer Financial Protection Bureau and capital requirements on
insurance companies.” To put it another way, the Republicans are the adults in
Congress while the Democrats, liberal to the core, will never admit we are
being set up for another financial crisis.

About Me

I am and have been for a long time a writer by profession. I have several books to my credit and my daily column, "Warning Signs", is disseminated on many Internet news and opinion websites, as well as blogs. In addition, I am a longtime book reviewer and have a blog offering a monthly report on new fiction and non-fiction.